CMA: How Wells Fargo is Weathering the Storm

Wells Fargo (NYSE:WFC) is the diamond in the rough, its perceived creditworthiness rocketing past its peers at the fastest rate in almost three months as investors reward the bank for limited risk from the European debt crisis and mortgage litigation that has been taking a bite out of financial firms like Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS).

Wells Fargo’s credit-default swaps have held steady this month, while contracts on JPMorgan Chase (NYSE:JPM) and other banks continue to climb, according to data provider CMA. The spread between Wells Fargo and its peers has more than doubled since August on heightened concern over the European debt crisis and credit crunch, costs tied to faulty mortgages, and pending regulations, all damaging banks’ balance sheets.

But Wells Fargo has had fewer mortgage-related costs than JPMorgan, both on an absolute basis and as a percentage of assets. Wells Fargo is being perceived as “a much more stable business, almost like an industrial company,” said George Strickland, who helps oversee about $12 billion in fixed-income assets at Thornburg Investment Management Inc. in Santa Fe. “They’re much more of a commercial bank. They didn’t get caught up in the mortgage fiasco as much as the other banks, and they also aren’t nearly as involved in the capital markets as the others.”

Credit-default swaps are are used by investors to hedge against losses on a company’s debt or speculate on creditworthiness. While credit-default swaps on Wells Fargo have climbed to 110 basis points since this year’s low of 95.5, contracts tied to its peers have risen much faster.

The gap between Wells Fargo swaps and the average of those linked to the six biggest banks in the U.S. — including Citigroup (NYSE:C), Morgan Stanley (NYSE:MS), Goldman Sachs, JPMorgan, and Bank of America — widened to 112 basis points yesterday, compared to 42 basis points at the beginning of August, and 23 basis points at this time last year. The gap widened to as much as 180.8 basis points in October, when Greece’s debt woes roiled markets.

The gap between Wells Fargo and its peers grew 22.3 basis points in the two weeks ended February 15, the fastest rate since November 25. Each basis point equals $1,000 annually on a contract protecting $10 million of debt, and that means bond investors are willing to accept lower interest rates in exchange for the safety afforded by Wells Fargo.

Investors have been growing increasingly more concerned about banks’ ability to generate revenue once Dodd-Frank takes full effect, but the new regulations won’t impact Wells Fargo the way they will hit Morgan Stanley, Goldman Sachs, Citigroup, or Bank of America, as Wells Fargo is more “domestic-focused” than its peers, according to Peter Tchir, founder of TF Market Advisors in New York.

Wells Fargo had just $3.2 billion in European sovereign debt holdings as of July 19, when CFO Timothy J. Sloan discussed earnings with analysts and investors. The six biggest U.S. banks together had $50 billion in risk tied to five of the most troubled nations in Europe as of September 30, according to Fitch Ratings. When Moody’s Investors Service announced yesterday that it had put 17 major banks and securities firms under review for downgrades, Wells Fargo was not among them.

Exposure to the mess in Europe may be one factor in investor caution, but another equally important factor is the cost of the crackdown on mortgage lenders in the wake of the 2008 financial crisis and ensuing collapse in the housing market. So far, faulty mortgages and shoddy foreclosures have cost the biggest U.S. banks upwards of $72 billion. About 0.8 percent of JPMorgan’s assets — $18.5 billion — were casualties to mortgage-related settlements, while Wells Fargo has only lost $6 billion, or 0.5 percent.

Though by no means the biggest, and maybe not even the strongest of the major U.S. banks, it seems Wells Fargo is the safest. The firm has so far weathered the storm threatening to sink many of its brothers in arms relatively unscathed, and investors are counting on that being the case in months to come.